Editor’s note: Later posts in this series revise the loophole’s size to $59 million, according to newly available 2014 data from the WA OFM. The $63 million noted below is based on earlier calculations.

Over the past six decades, Washington has given away hundreds of millions of dollars in tax revenue through a loophole that no one, in 63 years, has been able to properly justify or explain. The main beneficiaries of the loophole are some of the most profitable, and least responsible, companies in the world. And what’s more, the loophole was never intended to be used by these companies at all.

Anacortes Oil Refinery, photo by Ryan Healy

Anacortes Oil Refinery, photo by Ryan Healy

Say hello to the Extracted Fuel Exemption.

This loophole will cost the state at least $63 million over the next two years, at the same time we are facing a $1 billion dollar shortfall. So it was a credit to outgoing Governor Gregoire that her proposed 2013-15 budget closed this wasteful exemption, though it was almost entirely overlooked in news accounts.

The Extracted Fuel Exemption is a loophole in the state’s use tax, which you may never have heard of, so here’s a quick backgrounder. The use tax applies to things that are purchased for use in Washington, but that are not subject to sales tax. For example, if you buy a vehicle in Oregon, where the state does not assess a sales tax, you pay Washington’s use tax when you register your car back home in the Evergreen State. The use tax is also applied to substances used in manufacturing processes in cases when sales tax has not been levied on those substances.

In the case of “extracted fuel,” the exemption allows firms to avoid paying use tax on fuel that they produce and use internally. In the heyday of Washington’s timber industry, it was common for sawmills to use the wood scraps created by milling lumber—called “hog-fuel” in the industry—to produce energy to run the plant. It’s a classic form of energy efficiency: sawmills could re-use waste by burning their hog fuel to power the plant.

According to the “2011 Tax Preference Performance Reviews” by the Joint Legislative Audit and Review Committee (JLARC), in 1948, the state supreme court ruled in favor of a tax exemption for hog-fuel. Then, in 1949, the legislature changed the tax code for use taxes, and to avoid over-ruling the decision from the year before, the legislature created the extracted fuel exemption that we have today. The JLARC report mentions that, “It is not clear why the legislature carved out a specific preference for fuel produced and used by the extractor/manufacturer that produced it.”

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  • So the extracted fuel exemption was designed for hog-fuel, but the original intent was lost long ago. In 1949 there were no oil refineries in Washington. Yet since 1954, five refineries have set up shop in the state and have gone, um, hog-wild with the exemption. According to the JLARC study, these five refineries now receive 98 percent of the benefit from the extracted fuel exemption. How? Oil refineries produce fuel, but they use a lot of fuel in the process. According to the US Department of Energy, up to 60 percent of the energy that oil refineries use is actually by-products of fuel that they created on site. The language of Washington’s exemption—applying to fuels used to manufacture the same type of product—is loose enough to allow oil refineries to get a tax exemption on the oil by-products they use in the process of creating refined petroleum products.

    Washington’s extracted fuel exemption is an anomaly in the US. Of 45 states that have use taxes, 29 of which also have oil refineries, only one state other than Washington (Alabama) has a similar exemption, and it is more narrowly defined for petroleum products.

    In Washington, the tax exemption seems to have been meant for the sawmills that use hog-fuel, but the too-broad language allowed the oil industry to exploit it into a lucrative, if accidental, loophole.

    In Governor Gregoire’s recently proposed budget for 2013-2015 she proposes closing the extracted fuel loophole. The savings—her budget estimates $63 million in state revenue over two years—is enough to cover 7 percent of the $900 million budget shortfall. Yet it’s incoming Governor Inslee and the new legislature who will ultimately decide on whether the exemption stays or goes. Inslee has indicated he will go his own way on legislative priorities, but he should listen to Gregoire on this issue; it would be hard to see keeping the loophole as anything but a purposeful kickback to oil refineries in the state.

    Giving away millions to the state’s oil industry every year is hard to understand. At a time when the state is facing serious budget shortfalls and is trying to cut emissions, subsidizing oil refineries simply doesn’t add up.


    Update 1/17/14: For more information about this tax loophole, you can find additional resources listed here. See, especially, the “Tax Exemption Fact Sheets” published by the Washington Office of Financial Management in March 2013. Also see: SIGHTLINE FACT SHEET: Washington’s Extracted Fuel Tax Loophole